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Reasons for Holding Cash Determining the Target Cash Balance Managing the Collection and Disbursement of Cash Investing Idle Cash Summary & Conclusions
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The Baumol Model The Miller-Orr Model Other Factors Influencing the Target Cash Balance
Costs in dollars of holding cash Total cost of holding cash Opportunity Costs
Trading costs C*
2
C
C 2
T F C
Time
Time
Total cost =
C T K + F 2 C
Opportunity Costs
The optimal cash balance is found where the opportunity costs equals the trading costs
C K 2
C T K = F 2 C
Trading costs C*
Size of cash balance The optimal cash balance is found where the opportunity costs equals the trading costs
T F C
C2 K =TF 2
C 2 = 2
T F K
C* =
2T F K
C* =
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2TF K
C* =
2TF K
Assume Stetson Corp. has fixed costs of selling securities of $800, cash outflows exceed inflows by $50,000 per week, and the interest rate on marketable securities is 8%. Calculate their target or optimal cash balance. Answer:
The firm allows its cash balance to wander randomly between upper and lower control limits. $ H
Z L
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Time
Given L, which is set by the firm, the MillerOrr model solves for Z and H Z* = 3 3 Fs 2 +L 4K
To use the Miller-Orr model, the manager must do four things: 1. Set the lower control limit. 2. Estimate the standard deviation. 3. Determine the interest rate. 4. Estimate the trading costs. The model clarifies the issues of cash management: The best return point, Z, is ______ related to trading costs, F, and ____ related to the interest rate K. Z and the average cash balance are ________ related to the variability of cash flows.
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H * = 3 Z* 2 L
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where 2 is the variance of net daily cash flows. The average cash balance in the Miller-Orr model is 4Z * L Averagecashbalance = 3
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H * = 3 Z * 2L
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Float
Managing Float
Check mailed Payers view of delays: Payment Float Mail float
The difference between bank cash and book cash is called float. Float management involves controlling the collection and disbursement of cash. How have you seen float personally?
Availability float
Check Clears
Check Clears
Presentation float
Accelerating Collections Delaying Disbursements Disbursement Float Zero-Balance Accounts Drafts Ethical and Legal Questions
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Accelerating Collections
Customer mails payment Company receives payment Company deposits payment
Cash received
time AR
Mail delay Processing delay Clearing delay
Local Bank Collects funds from PO Boxes Envelopes opened; separation of checks and receipts
AP
Mail float
Processing float
Clearing float
Collection float
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Lockbox Example
Avg. no. of daily payments to lock box = 150 Avg. size of payment = $1,200 Rate of interest per day = .02 % Saving in mailing time 1.2 days Saving in processing time = .8 day Bank charges $ 0.26 per check plus $10,000 per year What is savings of LB, what is cost of LB? Answer:
Delaying Disbursements
Firm prepares check to supplier Post Office processing Delivery of check to supplier
1.
Write check on a distant bank. Hold payment for several days after postmarked in office. Call supplier firm to verify statement accuracy for large amounts. Mail from distant post office. Mail from post office that requires a great deal of handling.
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2.
3.
4. 5.
A firm with surplus cash can park it in the money market. Money market mutual funds. Sweep accounts
Firms have surplus cash for three reasons: Seasonal or Cyclical Activities Planned Expenditures Different Types of Money Market Securities
T-bill, T-notes, CDs, Federal Agency, Repros, Commercial Paper
FIN
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